When setting up your financial portfolio, you may wonder whether you are choosing the right mix of investments. You’ve probably heard that owning a well-diversified portfolio is key – but what does that mean?

Essentially, diversification means owning many different types of investments. It avoids the risk or limitations that come with concentrating assets in a single or even limited number of holdings, i.e. putting all your eggs in one basket, says Marty DeRouen, Certified Financial Planner and Wealth Management Advisor with DeRouen Girola & Associates. "Managing risk is an important component of investment portfolios. Every investment asset has a certain growth profile but also a specific volatility or risk profile. Our goal in portfolio design is to assemble a group of holdings in such a way as to target an appropriate "risk adjusted return” for an individual or couple’s scenario.”

When your portfolio is well-diversified across various asset classes such as stocks, bonds, commodities, and cash, the right mix can help protect your portfolio from bumps in the market. A broadly diversified portfolio is designed to have some assets perform well when others lag. Over time, that counterbalance tends to give you better results than having your whole portfolio ride on one type of investment.

The importance of diversification

A portfolio with a basic combination of stocks and bonds is likely to perform better over time than a portfolio of stocks alone. Yes, stocks are important for growth. But bonds can act as buoys that help prevent your portfolio from sinking as low as it might when stocks run into a major storm. For example, in 2008 when stocks lost 37%, core bonds gained 5%. So although diversification doesn’t eliminate volatility, it can help to lessen the blow.

While this example helps to illustrate the long-term value of being diversified, you don’t want to stop at the basic stock-and-bond level of diversification.

David Girola, Certified Financial Planner and Wealth Management Advisor with DeRouen Girola & Associates says portfolio diversification thoughts tend to be limited to the world of just the traditional investment markets (U.S. large, mid and small cap, international, commodities, fixed income, etc) and traditional market sectors (technology, financials, manufacturing, consumer goods, etc). "While this is certainly a fundamental technical aspect of investment portfolio design, we suggest that consideration of diversification be broadened to include all of an individual’s or couple’s assets and address diversifying across such areas as taxation, ease of accessibility, growth potential, extent of volatility, degree of certainty, and income potential.”

What is an ETF and how does it benefit a portfolio?

An exchange-traded fund (ETF) is a form of mutual fund which is freely traded on a stock exchange in the same way that individual stock shares are traded. They usually track a specific index, a commodity, or a basket of assets like an index fund. They can be attractive to investors due to their low costs and tax-efficiency. There is no front or back-end load charge, and the only cost to buy and sell is the standard brokerage charge. Like mutual funds, they also charge an annual maintenance fee, but the annual fee for an ETF is often lower than a traditional fund. Conversely, warns DeRouen, investors need to be aware that because an ETF mirrors an index fund philosophy, low cost means the holdings are "unmanaged” over time.

Many investors strive for portfolio diversification on their own; others prefer the assistance of a professional financial planner. Which is more beneficial financially? "Our experience from clients that come to us after DIY’ing for years is that they ultimately weren’t satisfied with the experience and the outcome,” says Girola. "They often acknowledge that somewhere along the way, they let their emotions or their lack of expertise mislead them into making poor decisions that offset the positives they thought they would see. Engaging with a professional to support both their investment portfolio as well as their overall financial planning should also free them up to focus on other things in life that matter most, like their work, their family and friends, and their hobbies.”

DeRouen emphasizes that no one investment or type of asset should be viewed as the best one. "The reality is that a diverse set of holdings that have a variety of financial characteristics will ultimately lead to having choices when needed, or passed on, and that’s what will really matter.”

Northwestern Mutual: DeRouen Girola & Associates, is located at 127 Broad St. #600, Lake Charles. For more information, call 337-436-8940.